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The following post was published on the Knowledge@Wharton website on January 2, 2013.

Empirical research has shown that "opportunity-driven" entrepreneurship is the wellspring of growth in the modern market economy. In Japan, the relative dearth of opportunity-driven entrepreneurship has contributed to the nation's economic malaise over the past two decades -- since the asset price bubble burst in 1991.

Although there are encouraging signs -- given the sophistication of Japan's technological base, the promise of female entrepreneurs, the advent of start-up incubators and the rise of "intra-preneurship" within established companies -- entrepreneurship levels today are markedly low relative both to pre-1991 Japan and to current levels in other developed countries. Ironically, during Japan's two lost decades, foreign-run enterprises, small businesses and entrepreneurs accounted for nearly all job creation. To revitalize its sluggish economy, Japan must create incentives to promote homegrown start-ups and must rapidly commercialize patented, cutting-edge technologies.

Japan is currently facing a myriad of intractable and unprecedented challenges -- from a demographic crisis to border conflicts to a strong yen. The population is aging quickly. The energy sector is still reeling from the March 2011 Tohoku earthquake, tsunami and nuclear disaster. The younger generation, having grown up amid deflation and economic stagnation, is loath to take career risks. Students are studying abroad in fewer numbers. Tepid economic growth, combined with massive public sector debt and continued deficits, will likely produce a fiscal crisis in the near future -- despite the fact that more than 90% of the debt is held domestically. Gross public debt to GDP now stands at nearly 250%. In spite of government efforts to raise cash by boosting the consumption tax rate, a financial implosion may come soon if interest rates ratchet up. It appears that Japan is stuck in an economic Catch-22.

The Japan Center for Economic Research projected GDP to flat-line for the next 40 years. But this prediction may be too rosy absent any drastic changes in Japan's policies. One former advisor to Prime Minister Hashimoto actually hopes that Japan "will confront a meaningful crisis this decade," so the country will be compelled to alter its policies. With crisis comes opportunity.

GDP growth derives from three factors -- an increase in the workforce, invested capital, and the productivity of labor and capital. Given Japan's shrinking population and overstretched government coffers, economic expansion must arise from productivity gains. New companies have propelled most of the productivity growth and job creation. Kyoji Fukao, of Hitotsubashi University, and Hyeog Ug Kwon, of Nihon University, noted that Japanese companies founded after 1996 contributed a net positive of 1.2 million new jobs, whereas older companies shed a net 3.1 million jobs. In 1989, Japan's Ministry of International Trade and Industry (now called the Ministry of Economy, Trade and Industry) cautioned that a reduction in entrepreneurship would result in economic slowdown. The warning was prescient.

How Does Japan Compare to Other Advanced Economies?

The World Bank has shown that, among Organisation for Economic Co-operation and Development (OECD) countries, Japan ranks dead last in the average annual entry rate of new enterprises. This rate recently slumped to less than a third of that in the U.S.

Data from the OECD Science, Technology, and Industry Scoreboard reveals that, both in absolute terms and relative to GDP, Japan trails all other OECD countries in the annual amount of venture capital invested. According to 2008 figures, as a percentage of GDP, the U.S. deployed nearly 20 times more venture capital funding. The Kauffman Foundation found that nearly one out of every eight American adults (11.9%) is currently engaged in "entrepreneurial activity" -- among the highest rates for large developed economies. The Global Entrepreneurship Monitor found that 4.9% of U.S. adults between the ages of 18 and 64 are working actively to establish new businesses, compared to only 1.9% in Japan.

Japan has also witnessed a steep decline in the number and volume of IPO filings. According to data from KPMG Japan, the number dropped from 204 in 2000 to 121 in 2007 and to 20 in 2009. In comparison, according to Renaissance Capital, U.S. firms filed 298 IPOs in 2007, 119 in 2009 and 261 in 2011. In addition, the American Chamber of Commerce in Japan has observed that exit opportunities via buyouts, corporate acquisitions or joint ventures remain limited.

A 2009 survey by the Global Entrepreneurship Monitor measured perceptions about entrepreneurship in 20 innovation-based advanced economies. Japanese citizens demonstrated the highest level of fear of failure, while Americans were in the quintile displaying the lowest level. Moreover, Japan, followed by South Korea, had the fewest citizens who saw opportunities in entrepreneurship. The U.S. was close to the median. Japan also ranked last in the proportion of people interested in entrepreneurship as a career. One entrepreneur stated that the eco-system in support of entrepreneurship in Japan is "less than 1% of that in Silicon Valley."

Japan's dearth of entrepreneurs is not for lack of technological sophistication. The country's R&D spending rate surpasses that of all other OECD countries, running on average around 3% of GDP. Research conducted by Robert Eberhard and Michael Gucwa, of the Stanford Program on Regions of Innovation and Entrepreneurship, demonstrated that Japan has a considerable patent advantage in Asia, particularly in renewable energies. Given the March 2011 nuclear accident, the impetus to find renewable, eco-friendly sources of power has become even more urgent, and there will likely be more Japanese patents in this area. This vast storehouse of patents could serve as the foundation for dozens of enterprises in the new economy. Thus far, however, Japan's patent base is considerably underutilized and has not translated into many start-ups or commercial products.

Why Is Japan Lagging in Entrepreneurship?

Japan-based venture capitalists, entrepreneurs, CEOs of SMEs, academics, financiers and former government officials have largely attributed Japan's entrepreneurship gap to cultural, societal, educational, legal and financial factors. There is also a failure of political will.

Cultural Factors: The impact of culture cannot be underestimated, as it directly informs behavioral norms. Tomoko Inaba, a former AIG Director and current entrepreneur in Japan, commented that, in general, the Japanese culture is "not one that encourages risk-taking behaviors or the pursuit of unexploited opportunities." It tends to be more cognizant of rules, tradition and customs, and it encourages highly conscientious and detail-oriented behaviors. It emphasizes conventionality, consistency, community and relative risk aversion. In contrast, the American culture tends to embrace individualistic and nonconforming behavior. It tends to foster debate, forgive failure and cultivate the development of open-mindedness and creativity. The Kauffman Report argued that the culture of the U.S. is the strongest force driving entrepreneurship there. In Japan, on the other hand, the fear of failure and resulting social alienation pose a huge psychological barrier for would-be entrepreneurs.

Societal Factors: Toshiko Oka, the CEO and founder of Abeam M&A Consulting Ltd., noted that the status of entrepreneurs in Japan is not high, particularly relative to their counterparts in the U.S. Inaba agreed, commenting that society's perception of entrepreneurs is neutral at best. She added that the "typical Japanese parent often does not support his or her child's aspiration of becoming an entrepreneur." These parents tend to want their children to go to an elite public university and join the bureaucracy or a major conglomerate (keiretsu), such as Mitsubishi or Mitsui. A well-known publicly traded firm, such as Toyota or Hitachi, also suffices. Due to historical patterns of lifetime employment (shushin koyo), the vast majority of parents still believe these paths present the most stable careers, the highest cumulative pay and the most prestige.

Because of the social pressure on men to support the household, married women can be better situated to become entrepreneurs. Men tend to wait until after age 30 to consider entrepreneurship.

Many successful entrepreneurs in Japan have spent time studying abroad. Kosuke Mori is representative of such entrepreneurs. He graduated from Tokyo University in 2000 and joined Mizuho Financial's leveraged finance unit. In 2004 he moved to California to attend graduate school at Stanford University. After graduation he launched his first company, a financial data aggregator targeting U.S.-based hedge funds. He stated that his education in the U.S. and the connections he formed within the venture capital community gave him the confidence to incorporate his company. He noted that, had he stayed in Japan, he would not have pursued his dream of entrepreneurship. He now runs a company that provides real-time consumer survey data via a smartphone-based app.

When he graduated from Stanford, Mori said he felt that Japanese society was cautiously optimistic. Now the society has become deeply pessimistic and conservative. Neither students nor businesspeople take risks and "the younger generation has become less ambitious." In the 1970s and 1980s, Japan, Inc. aimed to catch or even surpass the U.S. But today that goal seems far-fetched, according to experts. The younger generations are uncertain about economic growth and have come to question the relentless work ethic of the older generations. There is a clear ambition gap. Such a climate, these experts add, does not bode well for entrepreneurship.